The Debt Ratio: Calculation and Automation

The debt ratio (aka, the debt-to-assets ratio) represents the proportion of a company's total assets financed by debt. You can calculate it as total debt divided by total assets. The debt ratio is expressed as a percentage.

So, what should fund a company’s assets?

Ideally, not debt. Funding all company assets via debt means the company might be at risk of default if interest rates rise. Consequently, when undertaking a long-term review of a company’s financial health, stakeholders must calculate the debt ratio carefully.

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The debt ratio is an important signal of a company’s leverage and ability to service its debt commitments. Investors reviewing a company’s debt ratio will use it to predict its future financial health.

The lower the debt ratio, the better. For example, a debt ratio of 20% indicates that the company is more financially stable than a company with a debt ratio of 40%. The typical debt ratio will depend on the company’s industry.

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Here are the two most widely accepted ways of calculating the debt ratio.

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1. Divide the Total Debt by the Total Assets

• Calculate Total Assets by adding Total Liabilities + Equity (Both are on the balance sheet).
• Calculate the Total Debt by adding all short-term and long-term debts the company owes.
• Then, divide the Total Debt by the Total Assets.

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2. Divide the Total Liabilities by the Total Assets

• Calculate the Total Liabilities by adding together all short and long term liabilities.
• Finally, divide the Total Liabilities by the Total Assets.

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‍IBM defines automation as ‘the application of technology, programs, robotics or processes to achieve outcomes with minimal human input’. The qualifier ‘with minimal human input’ captures what automation should do: remove as much labour as possible when quickly compiling debt ratios in bulk.

Currently, there is no way to automate the debt ratio calculation without some human oversight. Firstly,  a financial statement’s structural and lexical complexity make it difficult for AI technology to select the right inputs (i.e. the correct items from the balance sheet).

Manually calculating the debt ratio requires the following:

• Reading the financial statement
• Copying the relevant data (e.g. into a useable format like Excel)
• Completing the calculation
• Checking the calculation for accuracy
• Actioning the completed ratio (e.g. copying it into a spreadsheet)
• Rinse and repeat

Consequently, using Excel or a similar tool to calculate the debt ratio is not a fully automated solution as it still requires a high volume of human input. If you’re looking for an automated solution, there are two options: asking an AI virtual agent or using a specialised tool like Financial Statements AI.

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Option 1: Ask an AI Virtual Agent

You could use an AI virtual agent like ChatGPT, Claude or Gemini to calculate the debt ratio. Here are the steps for how to do so:

1. Upload the financial statement (assuming you have permission to do so).
2. Prompt it (e.g. ‘Calculate the debt ratio from this financial statement PDF and export it in an Excel spreadsheet. Show all workings’).
3. Check the output (i.e. its suggested debt ratio), then download or copy and paste it.

Pro:

• You can also use ChatGPT to generate other financial ratios or KPIs. 

Cons:

• AI virtual assistants are known to hallucinate. For example, they might generate a plausible but incorrect debt ratio from your balance sheet.

• The free accounts for many AI virtual assistants are often restrictive – e.g. three files per day – which might make it a frustrating (and impractical) endeavour if you want to calculate the debt ratio in bulk.

In summary, ChatGPT automates the actual calculation part, but you will still need to check its output and manually move the data.

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Option 2: Use Financial Statements AI

Financial Statements AI extracts the raw data from financial statements and structures it into key metrics. You can then download the raw extracted and structured data together.

Finally, you can calculate the debt ratio using those metrics. 

Financial Statements AI, therefore, smooths out the process by giving you access to the key metrics (e.g. the Assets, Debts and Liabilities) in an Excel spreadsheet. You can then calculate the debt ratio in Excel using your preferred method.

Pros:

• Uploading financial statements in bulk is straightforward, making it easier to calculate the debt ratios of multiple financials.
• As Financial Statements AI has been trained on financial data, it will not generate hallucinations.

Cons:

• You will need to calculate the debt ratio yourself. However, as you would also need to double-check ChatGPT’s calculations, it shouldn’t significantly affect the time to data (TTD).

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Both options offer free versions:

• Financial Statements AI offers three trial uploads.
• ChatGPT offers three free uploads per day.

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While AI tools can expedite the calculation process, it is still up to analysts to decide what the data means. Using professional experience and judgement, they’ll be able to decide whether the way a company leverages its debts will compromise its future financial health, so they can then take action.

Unspecialised tools like ChatGPT will often be able to help, yet can seriously compromise data quality if left unchecked. Luckily, we’re entering a renaissance of AI-powered financial technology designed to overcome the limitations of publicly available AI models.

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To discover how you can get started with Financial Statements AI for free, book a demo or email our team at hello@evolution.ai.

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